Chapter 1

Forecasting

1
 Forecasting
1.1 Introduction

➢ Forecasting is the process of making predictions of the future

based on past and present data and most commonly by
analysis of trends.

2
 Forecasting
1.1 Introduction

Forecasting is important in many aspects of our lives. As

individuals, we try to predict success in our marriages,
occupations ‫وظائف‬, and investments. Organizations invest
enormous amounts based on forecasts for new products,
factories, and contracts with executives. Government agencies
need forecasts of the economy, environmental impacts, and
effects of proposed social programs.

3
 Forecasting
1.1 Introduction

Forecasting is also used to predict profits, revenues, costs,

productivity changes, prices, resources, and economic
indicators ( such as inflations, interest rates, and etc.)

4
 Forecasting
1.1 Introduction

Decision makers need forecasts only if there is uncertainty about

the future. Thus, we have no need to forecast whether the sun
will rise from the east. There is also no uncertainty when events

can be controlled; for example, you do not need to predict the

arrival time of employees to their work place. Many

decisions, however, involve uncertainty, and in these cases,

formal forecasting procedures can be useful.

5
 Forecasting
1.1 Introduction

Forecasting is often confused with planning. Planning concerns

what the world should look like, while forecasting is about what
it will look like.

Forecasting, goals and planning

Forecasting is a common statistical task in business, where it

helps inform decisions about scheduling of production,
transportation and personnel, and provides a guide to long-term

strategic planning
6
 Forecasting
1.1 Introduction

However, business forecasting is often done poorly and is

frequently confused with planning and goals. They are three
different things.

Forecasting is about predicting the future as accurately as

possible, given all the information available including historical
data and knowledge of any future events that might impact the
forecasts.

7
 Forecasting
1.1 Introduction

Goals are what you would like to happen. Goals should be linked
to forecasts and plans, but this does not always occur. Too often,
goals are set without any plan for how to achieve them, and no
forecasts for whether they are realistic.

Planning is a response to forecasts and goals. Planning involves

determining the appropriate actions that are required to make
your forecasts match your goals.

8
 Forecasting
1.1 Introduction

Forecasting should be an integral part of the decision-making

activities of management, as it can play an important role in
many areas of a company. Modern organizations require short-,

medium- and long-term forecasts, depending on the specific

application.

9
 Forecasting
1.1 Introduction

Short-term forecasts are needed for scheduling of personnel,

production and transportation.

As part of the scheduling process, forecasts of demand are often

also required. It covers days or weeks

Medium-term forecasts are needed to determine future resource

requirements in order to purchase raw materials, hire personnel,
or buy machinery and equipment. It covers months

10
 Forecasting
1.1 Introduction

Long-term forecasts are used in strategic planning. Such

decisions must take account of market opportunities,
environmental factors and internal resources. It covers a year or
more

11
 Forecasting
1.2 Common forecasts features

1- Conditions existed in the past will continue to exist in the

future.

2- Always there is a difference between actual results and

predicted values.

3- Forecast accuracy usually decreases with increasing time

horizon covered by the forecast.

12
 Forecasting
1.3 Elements of a good forecast

➢ Timely

➢ Accurate

➢ Reliable

➢ Expressed in meaningful units.

➢ In writing

➢ Simple to understand and use

➢ Cost effective
13
 Forecasting
1.4 Steps in the forecasting process

1- Determine the purpose of the forecast.

2- Establish a time horizon.

3- Select a forecasting technique.

4- Gather and analyze relevant data.

5- Make the forecast.

6- Monitor the forecast.

7- Modify the forecast if needed.

14
 Forecasting
1.5 Approaches to forecasting

1.5.1 Qualitative approach.

1.5.2 Quantitative approach.

15
 Forecasting
1.5.1 Qualitative approach.

Qualitative forecasting techniques are subjective, based on the

opinion and judgment of consumers, experts; they are
appropriate when past data are not available. They are usually
applied to intermediate- or long-range decisions.

Qualitative forecasting techniques rely on analysis of subjective

inputs which often lack precise numerical description . It is
known as judgmental forecast.

16
 Forecasting
Judgmental or opinion forecasts occur in some situations like:

❑ Quick forecast is required while no available quantitative data

❑ When political and economic conditions are changing and

available data may be obsolete.

❑ The introduction of new product or the redesign of existing

one

17
 Forecasting
Who makes judgmental or opinion forecasts ?

Forecasts are based on executive opinions, customer surveys,

opinion of the sales staff, and opinions of experts.

➢ Executive opinions

A small group of upper-level managers meet and collectively

develop a forecast. This approach is used as part of long range
planning and new product development. There is a risk that
the view of one person may prevail.

18
 Forecasting
➢ Sales force opinions

Good source of information due to direct contact with

consumers. Some drawbacks are

-may be unable to distinguish between what customers would

like to do and what actually will do

- May be influenced by recent experiences ( low sales or good

sales )

19
 Forecasting
➢ Customer surveys

Collecting information from samples of customers directly

➢ Experts opinions

May include advice on political or economic conditions

20
 Forecasting
1.5.2 Quantitative approach.

Rely on analysis of objective inputs which use numerical data

obtained from history, or time series . Quantitative forecasting
models are used to forecast future data as a function of past
data. They are appropriate to use when past numerical data is
available and when it is reasonable to assume that some of the
patterns in the data are expected to continue into the future.
These methods are usually applied to short- or intermediate-
range decisions.
21
 Forecasting
Quantitative forecasts are based on time series data

➢ Time series data are time-ordered sequence of observations

taken at regular intervals over a period of time (hourly, daily,
weekly, …etc.)

➢ The data may be measurements of demand,, revenues, profits,

productivity, …etc.)

➢ The assumption is that future values can be estimated from

past values

22
 Forecasting
Time series data can take different patterns such as:

➢ Trend… gradual long term movement ( upward or

downward)

➢ Seasonal variations…short term, fairly regular variations.

➢ Cyclic variations…wave-like variations more than one year’s

duration

➢ Irregular variation… due to unusual circumstances

➢ Random variation…due to common causes of variation

23
 Forecasting
Time-Series Forecasting

Time-series forecasting is a quantitative forecasting technique. It

measures data gathered over time to identify trends. The data
may be taken over any interval: hourly; daily; weekly;
monthly; yearly; or longer.

Trend, cyclical, seasonal and irregular components make up the

time series. The trend component refers to the data's gradual
shifting over time. It is often shown as an upward- or
downward-sloping line to represent increasing or decreasing
trends, respectively.
24
 Forecasting
Time-Series Forecasting

Cyclical components lie above or below the trend line and repeat
for a year or longer. The business cycle illustrates a cyclical
component. Seasonal components are similar to cyclicals in
their repetitive nature, but they occur in one-year periods. The
annual increase in gas prices during the summer driving
season and the corresponding decrease during the winter
months is an example of a seasonal event. Irregular
components happen randomly and cannot be predicted.

25
 Forecasting

1.6 Techniques for forecasting

The selection of a forecasting technique depends on many factors:

➢ the context of the forecast,

➢ the relevance and availability of historical data,

➢ the degree of accuracy desirable,

➢ the time period to be forecast,

➢ the cost/ benefit (or value) of the forecast to the company, and

➢ the time available for making the analysis.

26
 Forecasting

1.6 Techniques for forecasting

Successful forecasting begins with a collaboration between the

manager and the forecaster, in which they work out answers to the
following questions.

1. What is the purpose of the forecast—how is it to be used? This

determines the accuracy and power required of the techniques, and
hence governs selection. Deciding whether to enter a business may
require only a rather gross estimate of the size of the market,
whereas a forecast made for budgeting purposes should be quite
accurate. The appropriate techniques differ accordingly. 27
 Forecasting

1.6 Techniques for forecasting

2. What are the dynamics and components of the system for which
the forecast will be made? This clarifies the relationships of
interacting variables. Generally, the manager and the forecaster
must review a flow chart that shows the relative positions of the
different elements of the distribution system, sales system,
production system, or whatever is being studied.

28
 Forecasting

1.6 Techniques for forecasting

3. How important is the past in estimating the future? Significant

changes in the system—new products, new competitive strategies,
and so forth.

29
 Forecasting
1.6 Techniques for forecasting

1- Naïve forecasts

2- Simple moving average

3- weighted moving average

4- Exponential smoothing

5- Trend forecasting

30
 Forecasting
1.6.1 Naïve forecasts

Naïve forecast for any period equals the previous period’s actual value. It is the
simplest forecasting technique, quick and easy but not accurate
❑ If the data series show no trend, then: Ft = At-1
❑ If the data series show trend, then: Ft = At-1 + (At-1 - At-2)
Where Ft is the forecasted value for period t and At-1 and At-2 are, respectively,
the actual values for period's t-1 and t-2.

31
 Forecasting
1.6.2 Simple Moving Averages

❑ It averages a number of recent actual values, updated as new

values become available. The simple moving average forecast
can be computed using the following equation:

Ft = MAn = ∑ Ai / n

it is called the n-points simple moving average

Where, i = “Age “of the data (I = 1, 2, 3…)

n = Number of periods in the moving average

Ai = Actual value with age i

Ft = Forecast for the time period t 32

 Forecasting
1.6.2 Simple Moving Averages

❑ It averages a number of recent actual values, updated as new

values become available. The simple moving average forecast
can be computed using the following equation:

Ft = MAn = ∑ Ai / n

it is called the n-points simple moving average

Where, i = “Age “of the data (I = 1, 2, 3…)

n = Number of periods in the moving average

Ai = Actual value with age i

Ft = Forecast for the time period t 33

 Forecasting
1.6.2 Simple Moving Averages

Disadvantage is that all values in the average are weighted

equally: the oldest value is given the same weight as the most
recent value.

34
 Forecasting
1.6.3 Weighted Moving Averages

❑ It is similar to a simple moving average, except that it assigns

more weight to the most recent values in a time series.

That is, the highest weights are assigned to the most recent value
in the moving average, then the less high weight, to the next
most recent value, and so on. Note that the weights sum to 1.

35
 Forecasting
1.6.3 Weighted Moving Averages

Ft = wn An + wn-1 A(n-1) + ………….. + w1 A1

Where, wn > wn-1 > …… > w1 are the n weights for the n points
in the average

Note that, ∑ wi = 1

36
 Forecasting
Forecasting accuracy

The forecast error (also known as a residual) is the difference

between the actual value and the forecast value for the
corresponding period.

Et=A t- Ft

where Et is the forecast error at period t, At is the actual value at

period t, and Ft is the forecast for period t.

37
 Forecasting
Example 1
Period Demand
Given the demand data for the last five 1 42
2 40
weeks, forecast demand for week 6 using 3 43
4 40
the following forecasting methods:
5 41
a) Three-points simple moving average,

b) Four-points weighted moving average using a weight of 0.4

for the most recent period, 0.3 for the next most recent, 0.2 for
the next, and 0.1 for the next.

c) If the actual for week 6 is 39, forecast demand for week 7

using the same weights as in part b). 38
 Forecasting
Solution

a) The 3 most recent actual values are : 41, 40, and 43, then;

F6 = (41 + 40 + 43) / 3 = 41.33

If actual demand in week 6 turns to be 39, the moving average

forecast for week 7 would be:

F7 = (39 + 41 + 40) / 3 = 40

b) The 4 most recent actual values are: 41, 40, 43, and 40, then;

F6 = 41 x 0.4 + 40 x 0.3 + 43 x 0.2 + 40 x 0.1 = 41

c) F7 = 39x 0.4 + 41 x 0.3 + 40 x 0.2 + 43 x 0.1 = 40.2

39
 Forecasting
1.6.4 Exponential Smoothing
Each new forecast is based on the previous forecast plus a
percentage of the difference between that forecast and the
actual value of the series at that point. That is:
New Forecast = Old Forecast + α (Actual - Old forecast)
Ft = Ft-1 + α (At-1 - Ft-1)
Or Ft = α. At-1 + (1 – α). Ft-1
Where; Ft = Forecast for period t
Ft-1 = Forecast for period t -1
α = Smoothing constant
At-1 = Actual demand or sales for period t -1

40
 Forecasting
Example 2
The following table illustrates the actual demand for periods
from 1 to 11. Using the exponential smoothing, find the two
series of forecasts for each period. One forecast uses α = 0.1
and one uses α = 0.4. Naïve forecasts are used to develop the
forecasts for period t = 2.

41
 Forecasting
α = 0.1 α = 0.4

Actual Forecast Error Forecast Error

Period t
Demand
Ft = Ft-1 Ft = Ft-1
At-1 - Ft-1 At-1 - Ft-1
+α.Error +α.Error
1 42 - - - -

2 40

3 43

4 40

5 41

6 39

7 46

8 44

9 45

10 38

11 40

12
42
 Forecasting
α = 0.1 α = 0.4

Actual Forecast Error Forecast Error

Period t
Demand
Ft = Ft-1 Ft = Ft-1
At-1 - Ft-1 At-1 - Ft-1
+α.Error +α.Error
1 42 - - - -

2 40 42 -2 42 -2

3 43 41.8 1.2 41.2 1.8

4 40 41.92 - 1.92 41.92 - 1.92

5 41 41.73 - 0.73 41.15 - 0.15

6 39 41.66 - 2.66 41.09 - 2.09

7 46 41.39 4.61 40.25 5.75

8 44 41.85 2.15 42.55 1.45

9 45 42.07 2.93 43.13 1.87

10 38 42.35 - 4.35 43.88 - 5.88

11 40 41.92 - 1.92 41.53 - 1.53

12 41.73 40.92
43
 Forecasting
Example 3
For the given sales data for a car each month, No. of
Month
cars
calculate forecast for the 11th month (F11), using:
1 40
❑ Naïve forecast
2 47
❑ Simple moving average MA . 3 43
❑ Four points moving average MA4 . 4 52
❑ Four points weighted moving average MAW4 5 59
6 64
using weights (0.4, 0.3, 0.2, 0.1)
7 62
❑ Exponential smoothing with error factor
8 65
α = 0.35 (smoothing factor). 9 68
10 72

44
 Forecasting
Solution
a) Simple moving average :

F11 = MA =( 40 + 47 + 43 …..+72 ) / 10 = 58 cars .

b) Four points MA4:

F11 = MA4 = ( 72 + 68 + 65 + 62 ) / 4 = 66.75 = 67 cars.

c) Weighted MAw4 :

Ft = wn An + wn-1 A(n-1) + ………….. + w1 A1

F11 = (0.4) (72) + (0.3) (68) + (0.2) (65) + (0.1) (62)

= 68.4 = 69 cars

45
 Forecasting
d) Exponential smoothing :

F11 = F10 + α (D10 – F10)

We use four points moving average, MA4 to

calculate F10

F10 = (68 + 65 + 62 + 64 ) / 4 = 64.75

F11 = 64.75 + 0.35 (72 – 64.75) = 67.29 = 68 cars

46
 Forecasting
1.6.5 Trend forecasting

A linear trend equation is used to develop forecasts

when trend is present. It has the form:

yt = a + b t where;

t = Specified number of time periods from t = 0

yt = Forecast for period t

a = Value of yt at t = 0 - or the intercept with Y axi

b = Slope of the regression line

47
 Forecasting
1.6.5 Trend forecasting

The equation can be plotted by finding two points on

the line. One can be found by substituting some
value of t into the equation and then solving for yt.

The other point is found by substituting another value

of t into the equation and then solving for the
corresponding yt

Plotting those two points and drawing a line through

them will yield a graph of the linear trend line.
48
 Forecasting
1.6.5 Trend forecasting

The coefficients of the line, a, and b can be computed

from historical data using the following two
equations that are identical to those used for
computing a linear regression line:

b = (n ∑t y - ∑ t ∑ y) / (n ∑ t2 – (∑ t)2)

a = (∑ y - b ∑ t) / n

Where; n = Number of periods,

y = Value of the time series 49

 Forecasting
week Unit sales
1.6.5 Trend forecasting

Example 4
1 700
Product sales of a firm over the last 10 weeks 2 724
3 720
are shown in the opposite table. Plot the data,
4 728
and visually check to see if a linear trend line 5 740
6 742
would Be appropriate. Then determine the 7 758
equation of the trend line, and predict sales 8 750
9 770
for weeks 11 and 12. 10 775
50
 Forecasting

1.6.5 Trend forecasting Week

y ty t2
t
Solution
1 700 700 1
The following table shows 2 724 1448 4
The computation of different 3 720 2160 9
∑’s in the equations of the 4 728 2912 16

trend line coefficients, a, 5 740 3700 25

6 742 4452 36
and b
7 758 5306 49
8 750 6000 64
9 770 6930 81
10 775 7750 100
∑ = 55 7407 41358 51385
 Forecasting
1.6.5 Trend forecasting

Solution

b = (n ∑t y - ∑ t ∑ y) / (n ∑ t2 – (∑ t)2)

= (10 x 41358 – 55 x 7407) / (10 x 385 – 552)

= 6159 / 825 = 7,51

a = (∑ y - b ∑ t) / n

= (7407 – 7.51 x 55) / 10 = 699.4

thus the trend line is yt = 699.4 + 7.51 t

52
 Forecasting
1.6.5 Trend forecasting

Solution

by substituting values of t into this equation, we obtain

forecasts for future periods. For the next two periods
11 and 12, the forecasts are:

y11 = 699.4 + 7.51 x 11 = 782.01

y12 = 699.4 + 7.51 x 12 = 789.51

53